17 Flexible Budgets, Overhead Cost Management, and Activity-Based Budgeting

Learning Objective 1

Flexible Overhead Budget A flexible budget is a budget that is valid for a relevant range of activity. It is not based on only one level of activity as we have seen with the static budget. Includes several possible activity levels. Based on only one activity level.

Advantages of Flexible Budgets A manager is faced with the following information from the static budget for June when the level of activity was 4,500 machine hours. Was there good control of electric costs? After preparing a flexible budget, the manager obtained the following information about cost control at 4,500 machine hours.

Activity Measure: Based on Input or Output? The number of units of output usually is not a meaningful measure in a multiproduct firm because it requires the addition of numbers of dissimilar products. Output should be measured in terms of the standard input allowed given actual output.

Formula Flexible Budget Total budgeted monthly overhead cost Budgeted variable overhead cost per activity unit Total activity units Budgeted fixed overhead cost per month × = +

Learning Objective 2

Flexible Overhead Budget Illustrated $2.15 × 6,000 = $12,900

Flexible Overhead Budget Illustrated

Flexible Overhead Budget Illustrated $24,360 + $16,550 = $40,910

Flexible Overhead Budget Illustrated Normal costing Standard costing Manufacturing Overhead Manufacturing Overhead Actual Overhead Applied Overhead Actual Overhead Applied Overhead Actual activity Standard allowed activity The difference lies in the quantity of hours used × × Predetermined overhead rate Predetermined overhead rate

Learning Objective 3

Overhead Application in a Standard-Costing System In a normal-costing system, overhead is applied based on the actual amount of resources used (e.g., labor hours, machine hours). In a standard-costing system, the standard amount of resources forms the basis of application. Since the application rate would be the same in both cases, the difference between them lies in the quantity of resources that is recorded. Standard costing = Standard quantity * application rate Normal costing = Actual quantity used * application rate

Learning Objective 4

Choice of Activity Measure The activity measure should be one that varies in a similar pattern to the way that variable overhead varies. As automation increases, many companies are using measures such as machine hours or process time for their flexible overhead budget. Dollar measures are subject to price-level changes and fluctuate more than physical measures.

Learning Objective 5

Overhead Cost Variances Variable-Overhead Variances Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate AH × AR AH × SR SH × SR Variable-overhead spending variance Variable-overhead efficiency variance

Variable-Overhead Variances Matrix Inc. has the following variable manufacturing overhead standard to manufacture one tent: 1.5 standard hours per tent at $13.00 per direct labor hour Last week 1,550 hours were worked to make 1,000 tents, and $20,460 was spent for variable manufacturing overhead.

Overhead Cost Variances Variable-Overhead Variances Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate AH × AR AH × SR SH × SR 1,550 × $13.20 1,550 × $13.00 1,500 × $13.00 Variable-overhead spending variance $20,460 $20,150 $310 Unfavorable Variable-overhead efficiency variance $19,500 $650 Unfavorable

Overhead Cost Variances Variable-Overhead Variances Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate AH × AR AH × SR SH × SR 1,550 × $13.20 1,550 × $13.00 1,500 × $13.00 $20,460 actual overhead costs 1,550 actual hours $20,460 $20,150 $19,500 $310 Unfavorable $650 Unfavorable Variable-overhead spending variance Variable-overhead efficiency variance

Overhead Cost Variances Variable-Overhead Variances Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate AH × AR AH × SR SH × SR 1,550 × $13.20 1,000 tents × 1.5 hours 1,550 × $13.00 1,500 × $13.00 $20,460 $20,150 $19,500 $310 Unfavorable $650 Unfavorable Variable-overhead spending variance Variable-overhead efficiency variance

What Does the Efficiency Variance Reveal? Variable-overhead efficiency variance did not result from using more of the variable-overhead items than the standard allowed amount.

What Does the Spending Variance Reveal? An unfavorable spending variance simply means that the total actual cost of variable overhead is higher than expected after adjusting for the actual quantity of activity used.

Fixed-Overhead Variances Fixed-overhead budget variance Actual fixed- overhead Budgeted fixed- overhead = _ Fixed-overhead volume variance Budgeted fixed- overhead Applied fixed- overhead = _ Predetermined fixed- overhead rate Standard hours allowed ×

Fixed-Overhead Variances Matrix, Inc. prepared this flexible budget for overhead: Total Variable Budgeted Fixed Machine Overhead Hours Rate 2,000 4,000 $ 2.00 9,000 4.50 8,000 2.25 The company’s actual fixed overhead for the period was $8,450, and it operated at a standard 3,200 machine hours. Matrix budgeted 3,000 machine hours during the period.

Fixed-Overhead Budget Variance Actual fixed- overhead Budgeted fixed- overhead = _ _ $550 Favorable $8,450 $9,000 = Budget Variance Results from paying more or less than expected for overhead items.

Fixed-Overhead Variances Fixed-overhead volume variance Budgeted fixed- overhead Applied fixed- overhead = _ 3,200 hours × $3.00 per hour = $9,600 Volume Variance Results from operating at an activity level different from the denominator activity. $9,000 Budgeted cost ÷ 3,000 Budgeted hours _ $600 Favorable = $9,000

Fixed Overhead Variances Cost $9,000 budgeted fixed OH $550 Favorable Budget Variance { $8,450 actual fixed OH Fixed overhead applied to products Volume 3,000 Hours Expected Activity

Fixed Overhead Variances Cost $600 Favorable Volume Variance $9,600 applied fixed OH { $9,000 budgeted fixed OH Fixed overhead applied to products Volume 3,000 Hours Expected Activity 3,200 Standard Hours

Capacity Utilization Volume Variance Results when standard hours allowed for actual output differs from the denominator activity. Unfavorable when standard hours < denominator hours Favorable when standard hours > denominator hours

Several Types of Analyses Variable- overhead spending variance Fixed- overhead budget variance Variable- overhead efficiency variance Fixed- overhead volume variance $1,680 U $2,500 U $1,800 U $7,500 U Combined spending variance $4,180 U $1,800 U $7,500 U Combined budget variance $5,980 U $7,500 U Underapplied overhead $13,480 U

Learning Objective 6

Overhead Cost Performance Report $19,200 - $19,350 = $ 150 $18,000 - $19,200 = $1,200 = Unfavorable variance

Overhead Cost Performance Report $1,680 + $1,800 + $2,500 = $5,980 unfavorable $57,000 - $62,980 = $5,980 unfavorable

Learning Objective 7

Standard Costs in Product Costing In a standard cost system: Unfavorable variances are equivalent to underapplied overhead. Favorable variances are equivalent to overapplied overhead. The sum of the overhead variances equals the under- or overapplied overhead cost for a period.

Disposition of Variances Manufacturing Overhead Cost of Goods Sold Actual Overhead $5,500 Applied Overhead $50,000 $44,500 $5,500 An alternative accounting treatment is to prorate underapplied or overapplied overhead among Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold.

Learning Objective 8

Activity-Based Flexible Budget $18,000 ÷ 4,500 units = $4.00 per unit $5,000 ÷ 10 runs = $500 per run

How Does ABC Affect Performance Reporting? The activity-based flexible budget provides a more accurate benchmark against which to compare actual costs.

Standard Costing in A JIT Environment A just-in-time manufacturing setting minimizes inventories. Some companies have simplified their accounting system by charging all manufacturing costs directly to Cost of Goods Sold.

Learning Objective 9

Proration of Cost Variances Generally, variances for direct and indirect costs are closed at the end of each period to the Cost of goods sold account. Logically, though, those variances are also related to the ending inventories of Materials, Work-in-process and Finished goods. The Cost Accounting Standards Board, which publishes rules for government contractors, requires that part of any cost variance be assigned to the related inventories. Example: The company purchased $5,000 of direct materials, of which 30% remained in inventory. If there is an unfavorable materials price variance of $250, we add $75 to Materials inventory.

Learning Objective 10

Standard Costing in a Just-in-Time Environment Businesses with a JIT management philosophy try to minimize their inventories. They simplify their accounting by charging purchases immediately to Cost of goods sold. Then, if any inventory exists at the end of the period, its cost is recorded and part of the Cost of goods sold is reduced. This method is known as backflush costing. JIT Backflush costing

Learning Objective 11

Sales Variance Analysis Sales are also subject to deviation from plans. The two most common types of analysis focus on (1) sales revenue and (2) contribution margin. Once again the variance measures the difference between budgeted and actual amounts. But now a variance is favorable if actual exceeds budget. Sales variances can be further divided into (1) sales-price and (2) revenue sales-volume variances. Additional analyses can be carried out on (1) revenue sales-mix, (2) revenue sales-quantity, (3) revenue market-size and (4) revenue market-share variances.

End of Chapter 17